lunes, 24 de agosto de 2015

lunes, agosto 24, 2015
How Afraid Should We Be Of The Margin Debt Climb?
             

Summary
  • Margin debt has risen to a historically unprecedented level relative to the US stock market, inflation adjusted.
  • Opinions vary on the significance of the NYSE margin debt figures in predicting market tops.
  • These figures should be viewed in a context with other, more predictive market indicators.
Ever since both the stock market and the level of borrowing to buy stocks with margin went over the top of the market together back in 2000, margin debt charts have been flashed by the bears as Halloween costumes to scare the bejesus out of the bulls. I'm not a big fan of portents, omens, and such in the market. Sure historic sell-offs happen, but if you look at the last 25 years and add up all the time when the broad market was in such historic dives, it amounts to something like 4% of the time. Good luck divining that sliver of the calendar. If you lend much of an ear to the bear arguments, they will keep you out of the market most of the 96% of the time you could be making return.

You hear the sensible bear arguments in any bull move all the way from the dead-cat-fool's bounce after a collapse through the false "jobless recovery" stage to the overvaluation stage and finally to the "irrational exuberance" end stage.

One big thing that seems to be missing in the market top picture right now is euphoric sentiment. If you listen or read at all on the markets, all you hear is freshly paved bricks of worry over China, oil, the Fed - the wall of worry a bull market keeps climbing on. Supposedly, it's when the talk is mostly about clear sailing ahead and sentiment goes ballistic that you get the big tops. But if you look at a collection of the sentiment surveys now, they are all over the map with mostly a pessimist bent.

I've never paid much attention to these surveys. For one thing, if they are all over the map, how reliable are they? And they seem to gyrate from gloom to giddy over very short periods, but actual market conditions change more slowly. One "sentiment" indicator I do pay attention to is what investors are actually doing, not what they are saying. Here I do, in fact, look at margin debt levels - how bold players are actually getting with their money.

A typical look at this was taken in a recent article at MarketWatch where they plot the latest in the margin climb:

(click to enlarge)

Margin debt has blitzed far beyond the '08 or '00 crash levels and is as stretched from the market as it ever gets in real, inflation adjusted terms.

But many, including Barry Ritholtz, have debunked the margin debt bogeyman, saying that it is not that significant. His points are that these peak NYSE debt figures amount to only about 3% of total NYSE market cap. Are you going to blame a 30% plus market crash on the reckless 3% who are forced sellers? And he points out that the margin buying is a natural result of a good market and vice versa - it is a "coincident" indicator, not a predictor. All valid points.

I agree that margin debt is a coincident indicator, a worthless predictor, and means only that we are closer to the next down cycle than we were before. So you have to combine it with other things that typically do have predictive value if you are to consider it as a predictor. You can do this if you take a graph like the one above and look closely at the market behavior during the peaking of the margin debt.

You have perhaps heard the old wisdom that bull stock markets don't end with a bang, they end with a whimper. The nature of a weak spell is what you want to pay attention to. An ongoing bull market typically has sudden, sharp, and brief sell-offs from fresh new highs - maybe lasting a couple months or so. At the end of a bull market, you usually have a protracted rolling over of new highs dragged out over a year or more - a whimper. This gently descends into a technical breakdown after which you get the violent sell downs. Let me illustrate:

(click to enlarge)

This is the 2000 top in the SPX with the margin debt peak shown in the sequence. The pairing of the 140 and 200 day exponential moving average is the best divider of bull and bear markets I have found. When something doesn't bounce up out of that range soon, it very typically indicates a big change in trend. And when these two lines draw closer to each other (negative divergence) it shows a badly weakening trend. In this one year period, we see this divergence, along with badly decaying money flow and the classic roll-over. Dow theorists like to also compare to the transports, but they nowadays are so controlled by commodity prices they can be misleading on the economy. I do look at the small caps (Russell 2000) because they quite typically lead the broader market in downturns. And it was doing just that over this one year period.

Now if we look at the next major top in 2007:

(click to enlarge)

Doesn't this all look familiar? What followed was the sharp sell-off in January, a meager recovery out to mid-year and then the epic decline. The four horsemen of the apocalypse - the roll-over, the negative divergence, the money flow decay, and a peak in margin debt were all there in the same formation.

So let's cut to the chase and see the current picture:

(click to enlarge)

Yes, it's all there. The Russell, as in 2007, has broken down below the moving average pair as has the Dow. The Nasdaq and SPX are the last men standing above this critical support. The April peak in margin is just 4 months old and the new figures published by the NYSE (there is about a month delay) should tell us if we are receding from the old peak or heading to a new one.

There seems to be something about margin foolishness run to extremes that closely precedes really bad behavior - as in Morgan Stanley's official position explained in an article last month in Business Insider Australia on China's recent crash. They see it being fueled by their high margin:
That's essentially what is happening on the Shanghai stock market according to Morgan Stanley in a note from the China Equity Strategy Team. They believe the selling is a healthy correction for the market and would "like to see further margin unwind, valuation normalization and/or corporate earnings improvement before we turn more constructive on China A shares."
And they take this position despite margin debt having only been about the same as it is currently on the NYSE:

(click to enlarge)

Note the margin debt at only about 4% of total market cap is accompanying all of China's frightening collapse, so our 3% is little comfort. It's also noteworthy that with each of the previous major tops, '00 and '08, China's market also participated by being a few months earlier than ours in the sharp collapse phase. They may have just begun to pull us down.

When the next margin fueled collapse does happen in the US, it may be worse than '08 because of the cash situation accompanying the current margin level.

Going into September 2008, there was a much healthier usable cash-to-margin condition. Now the Fed has less ammo and the margin fools have less cash.

The margin debt bogeyman is indeed a small, coincident number by itself. But if you combine it with meaningful, predictive market behavior as we have in the above charts, and think of it as perhaps a gauge of reckless psychology in general in the markets, it should command at least a little fear.

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